SUPPLY-SIDE ECONOMICS is based on the premise that high tax rates hurt the national economy by discouraging work, production, and innovation. President Ronald Reagan's adoption of supply-side economics as the underlying theory for his economic policy in the 1980s represented a major shift in U.S. economic thinking. Supply-side theory was far from new, however, its basic ideas dating back to the early-nineteenth-century works of Jean-Baptiste Say and David Ricardo. It had been ignored in the United States since the New Deal, because of the demand-side theories of the British economist John Maynard Keynes, who believed in raising income and reducing unemployment by expanding demand even if the government does so through deficit spending.
In the 1980s, supply siders found an audience looking for an alternative to deficit-oriented, demand-side policies. Arthur B. Laffer popularized the idea. He argued that cutting taxes, especially those of high income groups, would increase government revenues, because lower tax rates would produce more incentives for business and individuals to work and less reason for them to avoid taxes whether through non-productive investments in tax shelters or outright tax avoidance. Cutting taxes would result in more jobs, a more productive economy, and more government revenues. This theory fit nicely into the conservative political agenda, because it meant less interference with the economy and, when combined with spending cuts and deficit reduction, smaller government.
Supply-side economics dominated the administration of President Ronald Reagan, who instituted major tax cuts in 1981 and 1986, reducing the top U.S. rate from 70 percent to roughly 33 percent. However, Congress did not reduce federal spending to compensate for the reduced revenue, with the result that deficits soared to record levels. In the view of some advocates, the failure of Congress to adopt a balanced-budget amendment that would have controlled federal spending to match the tax cuts meant that supply-side theories were not really tried. Cutting taxes remained an important goal for subsequent Republican administrations, but by 2001, few argued that tax cuts would increase government revenue. Rather, tax cuts were a way to stimulate the economy, reign in government spending, and return the budget surplus to its rightful owners.
The legacy of supply-side economics has been more political than economic. In the mid-1990s, Republican House Speaker Newt Gingrich observed that supply-side economics has "relatively little to do with economics and a great deal to do with human nature and incentives." It contributed to the larger debate about the respective roles of government, individuals, and incentives in U.S. society as the nation faced a global economy.
Canton, Victor A., Douglas H. Joines, and Arthur B. Laffer. Foundations of Supply-Side Economics: Theory and Evidence. New York: Academic Press, 1983.
Thompson, Grahame. The Political Economy of the New Right. London: Pinter, 1990.
Wilber, Charles K., and Kenneth P. Jameson. Beyond Reaganomics: A Further Inquiry Into the Poverty of Economics. Notre Dame, Ind.: University of Notre Dame Press, 1990.
Winant, Howard A. Stalemate: Political Economic Origins of Supply-Side Policy. New York: Praeger, 1988.
Reawakened in the United States in the late 1970s and early 1980s, the theory of supply-side economics looked at economic behavior by analyzing the supply of consumer items instead of the demand for them. This view of economics specifically focuses on the disincentive effects of taxes on private sector productivity, investment, and growth. Supply-side economists argues that reducing the tax rates on the supply-side would lead to greater economic growth, greater employment, and larger bottom-line tax revenues later.
Supply-side economics is not new in economic thought; its roots can be traced to Jean Baptiste Say's Treatise on Political Economy and Taxation (1817). The renewed interest in supply-side economics of the 1980s was stimulated by Dr. Arthur Laffer's Laffer's Curve and by the administration of President Ronald Reagan (1981–1989), which adopted this kind of economic thinking.
The Laffer Curve established to calculate the highest rates of tax the market would bear in various areas of the economy, always emphasizing tax reduction as the solution to economic issues. The supply-side theory of economics calls for a reduced government, reduced government spending, and a de-emphasis on any fiscal targets. Instead, great emphasis is placed on the free market and the de-regulation of private industry by the government. By the end of the supply-side era of the 1980s, the U.S. national debt was higher than at any other period of its history. The tax cuts did stimulate business and bring in more revenue, but government spending continued to grow in spite of the rhetoric.